Energy’s Demand Shock, and The Acceleration of the Fossil Fuel Transition

Oil, gas and coal prices have fallen up to 50% over the past three years, yet according to BP’s latest Statistical Review, total energy demand growth has collapsed 45% at the same time.

The average annual energy demand increase of 1.8% pa over the past ten years has fallen to just 1% pa in the past three.

Weak energy prices are often attributed to supply-side issues, but a fall in global demand is now a far greater factor.

And it has wider implications.

This fall in demand coincides with the rise of new energy technologies – wind, solar and electric power-trains – allowing them to seize increasing shares of remaining incremental growth.

Ten years ago fossil fuels generated 95% of the energy demand increase; last year they provided just 35%.

The incumbent energy industry is now forced into a fierce competition for limited new demand, but it remains focused on a high growth agenda – attempting to force prices up and investing in more expensive production.

In contrast, the costs of new energy technologies are dropping rapidly, speeding up their deployment.

The slowdown in global demand is accelerating the energy transition as fossil fuels become less competitive in a market with lower-cost energy options.

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So Big it’s Invisible

Global energy demand is so big, it’s almost invisible.

So when demand shocks occur, they are never as obvious as supply ones.

They tend to happen gradually, but everywhere, building into a sudden widespread transformation

Whilst the structures of energy supply from drilling rigs to solar farms are solid and obvious, demand is determined more in the abstract: by efficiency, technology, economics, policies and the innumerable choices and strategies of governments, companies and consumers : India’s recent rapid switch to LED lighting a good example.

Perhaps we can only really see demand shocks coming by compiling huge ledgers of consumption data as BP does each year, and then stand back and look at the landscape to see how it has shifted.

In this context, the most significant number in BP’s latest Statistical Review of World Energy, released last week, is also the simplest: 1%.

Growth in world energy demand in 2016 (and 2015 and 2014) was 1%.

To put this in context, that growth is 45% below the average rate (1.8%pa) over the past 10 years.

Even though the notion of falling energy intensity is well-known, such a dislocation in demand is profound.

It is even more striking as it occurred as oil, gas and coal prices dropped by up to 50%: a 50% price discount but no rebound in demand – what is happening?

For BP, lower demand is due to a combination of factors most notably world-wide energy efficiency improvements, and the passing of China’s massive industrialization phase.

This is true – but only half the story; this demand shock has wider implications.

The drop in global demand also coincides with the rise, worldwide, of new competitive energy supply technologies; wind, solar and electric power-trains.

As new energy technologies quickly seize a larger share of lower energy growth, the competition with fossil fuels increases, and accelerates the energy transition.

Many analysts note how new energy sources will disrupt the industry in years to come (eg see here), but the BP Review shows the impact is dramatic and under way right now.

Most of the charts below are therefore derived from BP’s latest report, but the focus is on demand’s first derivative – change – rather than the absolute level , which is BP’s emphasis. And the focus is on the transition underway now, rather than 20 years hence.

The Rise of a Quiet Behemoth

source: BP, adapted dollarsperbbl

This shift in the energy landscape is most obvious by simply comparing the demand growth picture of 10 years ago, 2006-07, with last year. (Comparing selected years can be misleading, missing broader trends – but the defense of this analysis is given in footnote 1).

The picture could not be more stark.

Between the two years, energy demand growth has fallen over 60%, with fossil fuel demand down 85%.

Last year, global hydrocarbon supply had to fit into a 50mtoe demand growth box, one-seventh the size of the box from 10 years ago.

Just imagine for a moment the investment and supply infrastructure that was anticipated and commissioned in coal and oil and gas in 2007 on the back of that chart: many of those projects will still be in construction or operating full out.

If we break this down further it becomes clear that the largest moves in energy are the growth of wind and solar, and the decline of coal.

However, although BP majors on coal decline, it glosses over the fact that gas demand growth last year is 50% lower than in 2006, and a third below its 10 year average.

source: BP, adapted dollarsperbbl

The on-the-ground reality is that wind, solar and natural gas have all replaced coal so far, but the future impact of wind and solar growth will have a much larger influence a cross all fossil fuels.

Without needing to resort to long-term projections of 20-30 years ahead, it is clear that wind and solar are already a very different new source of energy competition than previous alternatives, such as nuclear.

BP highlight this fact in a dramatic summary of how quickly wind and solar are already disrupting the power market:

source: BP

In less than ten years , solar has gone from a niche, rounding-error technology, to generating substantial power (greater than 50GWh) in over 75% of the 67 countries that BP analyses.

Wind took just 20 years to do the same; but nuclear, over 50 years old, never managed higher than 40%.

This scale of mass diffusion now goes beyond policy support and subsidy – it is increasingly driven by economic forces, and the nature of the technology: wind and solar allow access to manufacturing learning curves, and the universal abundance of the energy source ensures rapid capacity deployment and cost improvements.

Whilst oil and gas enjoyed a decade of high prices, wind and solar quietly did their R & D, and assembled global supply chains.

Since 2009 solar and wind prices have therefore fallen by 70% and 40% respectively. They will fall below gas and coal prices in the next few years, having almost reached parity today.

The Battle for 500TWh

We can look at the shock to demand and rise of new technologies in another way.

Rearranging the BP data into the core energy markets of electricity, heating and industrial, and transport, shows how electricity remains the largest energy growth market, heating and industry is already in decline, and transport flat. (2)

source: BP, adapted dollarsperbbl

Electricity, energy’s largest growing market, is also the most impacted by the rise of new energy technology.

source: BP, adapted dollarsperbbl

Gas and coal provided over 95% of the energy for electricity growth of 880TWh in 2006-07; but by 2016, they contributed only 35% of the 530TWh required, a drop of 75%.

Wind and solar alone provided more TWh generating power in 2016 than gas and coal combined.

Let’s assume for a moment that electricity demand continues to grow at the current trend of 2.2% pa out to 2020, and that wind and solar plus nuclear and hydro grow at current rates too.

In a full reversal from 2006 non-fossil fuel technologies will be able to meet 95% of electricity growth requirements in 2020– see below.

source: BP, adapted dollarsperbbl

By 2023 or so, wind and solar will be able meet global electricity growth by themselves – and by that time their generation costs will be lower than coal or gas alternatives, and – because they are manufactured products, not commodities, their costs will be continuing to fall.

Lower commodity prices will not be enough to move the surplus of coal and gas supply – wind and solar offer lower prices, and also local energy supply: no vast new importation infrastructure is required.

Of course, fossil fuel incumbents are resisting this change – and point to wind / solar intermittency. But demand response and storage are solving these issues, and as the main arguments for wind / solar now centre on lower prices, local energy security, and better air quality such resistance will become hard to justify to citizen consumers.

This leaves all the world-wide production of gas and coal today to fit into a smaller and smaller fraction of a 500TWh pa growth box.

As the heating and industry market is in decline too, this pits gas and coal immediately in a zero sum battle for declining growth in all their energy markets, as wind and solar absorb more and more of incremental demand.

In electricity, the global energy transition is well underway.

The Last 1mb/d of Oil

Lower demand and increased supply competition is also altering the oil transport market.

It’s not so obvious from the high-level numbers that oil demand is in decline – but looking down a level into oil barrel products tells a different story.

The current headline summary for crude oil demand is an increase of 1.55milion barrels per day (mb/d) or 1.6% increase on 2015, and above the ten year trend of 1.2%pa.

But that headline figure has in fact been propped up recently by what BP refers to as “Others” – bitumen, lubricants and especially LPGs such as ethane and propane. LPGs are quite specific products aimed mainly at non-transportation sectors such as residential heating in Asia, and petrochemicals.

So, as the charts make plain, growth in the core transport energy market which depends on gasoline, jet fuel and diesel (80% of the barrel) has actually decreased, with a recent collapse in Asian diesel demand.

Growth in demand for these light and medium fractions has declined 10% from 2006-07, from 1.1mb/d to 0.98mb/d today. To be sure the demand has fluctuated quite a bit over the last decade, but post the financial crisis, average consumption 2010-15 has held around the 1mb/d mark.

The data also indicates that growth is actually evenly divided between the OECD and non-OECD markets, with a renaissance of diesel and gasoline demand in the US and Europe, and gasoline growth continuing in Asia, but below the ten-year average.

These are fragile gains, and maintaining the 1mb/d growth looks increasingly strained.

EU diesel demand will also be impacted by the VW diesel-gate saga, (new registrations of diesel cars are already down almost 10% in the UK market in 2017), and US gasoline demand is currently softening against a strong 2016.

The Modi government in India is also, understandably given their abundance of land and sun, looking to leap-frog fossil fuel dependence and move aggressively toward wind, solar and electric vehicle implementation: all new car sales are aimed to be electric by 2030.

In sum, the global upstream and downstream oil product supply chain is focused on a sub 1mb/d box of transport fuel growth, which is increasingly under substitution threat from electric power-trains in its main growth market.

An energy transition in oil is coming quickly as well.

An Industry Addicted to Higher Growth

What the BP data shows is an industry undergoing a profound transformation.

But even though energy prices have fallen and stayed low for over three years, the focus of the fossil fuel industry remains fixed on higher growth: intent on forcing prices back up, whilst investing in more steel and machinery and other infrastructure for future expansion.

The sprawling global hydrocarbon industry is hooked on high demand growth, and it seems unable to shake off its addiction.

Yet all the world’s fossil fuels and new energy supply can only fit in to two boxes of 500TWh and 1mb/d growth each year, and these boxes are growing smaller.

BP’s main statistical insight is that diminishing demand growth figure of 1% pa – and all that flows from it.

But BP, like its peers, is refusing to look at it.

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1 – The post does attempt to put the changes in context from BP’s data, where 06-07 or 15-16 are not representative. But in defense of this analysis it makes change look sharper, and shows how decisions in a long-cycle industry may have been justified at that time. Oil executives are paid to think slowly after all. Where change is gradual, but important, a snapshot of two years a decade apart can make the shifts clearer to see; mid-summer and mid-winter photos if you will.

2 – The global energy data for the sectors of electricity, heat/industry and transport were calculated roughly as follows from BP’s data:
• Electricity from the table on p-46 directly, and converted using BP’s convention (4.4TWh per 1mtoe)
• Transport simply the oil liquids data (p-19)
• Heat / industry from the difference between total energy minus electricity and transport
• The breakdown of fuels in electricity assumes that all of hydroelectricity, nuclear and renewables is used in electricity, and thus the gas/coal portion is the remainder after subtracting all of those from the total. That is in pretty good alignment with typical energy models eg this Sankey diagram from Lawrence Livermore laboratories. And pretty much how the world is working at the moment – maths modeling life (or vice-versa).